Chinese Bids for U.S. Tech Companies Come Under Closer Scrutiny

Following the federal government’s blocking of the acquisition of Aixtron’s U.S. division by Chinese interests, a growing chorus in Washington is asking whether standards for the review of foreign direct investment transactions need to be tightened.

Chinese industrial policy is increasingly distorting semiconductor markets in ways that undermine innovation and put U.S. national security at risk, a report by the President’s Council of Advisors on Science and Technology has concluded.

Published in the closing days of the Obama Administration, the study questions whether the current tools used to assess foreign direct investment (FDI) in U.S. technology companies, including trade agreements and executive branch review of such deals, are adequate to protect the country’s economic and security interests. It recommends that the U.S. and China negotiate and disclose the terms upon which FDI in each country is conditioned, with U.S. approval of future Chinese acquisition deals dependent on the latter government's adherence to transparent, agreed-upon policies.

“Semiconductor innovation is already slowing as industry faces fundamental technological limits and rapidly evolving markets,” note the authors of the report, Ensuring Long-Term U.S. Leadership in Semiconductors, which include academicians as well as leaders from the U.S. semiconductor industry. “Now, a concerted push by China to reshape the market in its favor, using industrial policies backed by over $100 billion in government-directed funds, threatens the competitiveness of U.S. industry and the national and global benefits it brings.”

At issue are China’s “IC Promotion Guidelines,” announced in 2014, which were designed to boost the country’s semiconductor capabilities to “advanced world level in all major segments of the industry by 2030.” While China has many semiconductor foundries, “all are at least one-and-a-half generations behind the state of the art in volume production,” the report notes. Moreover, neither locally owned memory companies producing at commercial volume nor tier-one semiconductor equipment firms are currently located in China.

U.S. concern over the initiative stems from the perception that China—a World Trade Organization (WTO) member since 2001, and now seeking “market economy status” by that body—is, in fact, seeking to achieve a global leadership position in semiconductor design and manufacturing through non-market means.

“China’s effort to move up the value chain should be the result of healthy competition and free and fair trade, not state-directed investments aimed at distorting global markets,” former U.S. Secretary of Commerce Penny Pritzker told an audience at the Center for Strategic and International Studies last November. “In addition, no government should require technology transfer, joint venture, or localization as a quid pro quo for market access.”

Blocking of Aixtron Acquisition

Further evidence of the changing mood in Washington toward Chinese FDI in U.S. technology companies came one month after Pritzker’s speech, when former President Barack Obama issued an order prohibiting the acquisition of the U.S. business of Aixtron SE, which manufactures metalorganic chemical vapor deposition systems to build compound semiconductor materials. It represented only the third time in history that a U.S. president had blocked a transaction based on the recommendation of the Committee on Foreign Investment in the United States (CFIUS), an interagency committee of the U.S. government that reviews the national security implications of foreign investments in U.S. companies or operations.

“Grand Chip, a German limited-liability company ultimately owned by investors in China, some of whom have Chinese government ownership, is a special purpose-investment vehicle established for this transaction,” the U.S. Department of Treasury, which chairs CFIUS, noted in comments announcing the decision. “The national security risk posed by the transaction relates, among other things, to the military applications of the overall technical body of knowledge and experience of Aixtron, a producer and innovator of semiconductor manufacturing equipment and technology, and the contribution of Aixtron’s U.S. business to that body of knowledge and experience.”

But will the Trump Administration continue efforts to crack down on FDI transactions executed by investment firms backed by the Chinese government?

“It's a very good question,” says Dan Hutcheson, CEO and chairman of VLSI Research. “In my opinion, you’re going to see a more aggressive approach toward [oversight of] M&A involving Chinese companies—especially if something like the VAT [value-added tax] goes through, because that could potentially be very expensive for Chinese companies trying to export products to the United States.”

President Trump has already announced the formation of the White House National Trade Council, whose mission includes advising on trade negotiations. The council will be headed by Dr. Peter Navarro, author of the book Death by China, who will also serve the President as director of trade and industrial policy.

During the 2016 presidential campaign, Navarro—a longtime critic of U.S. trade policy toward China—served as economic adviser to Trump together with newly confirmed U.S. Secretary of Commerce Wilbur Ross. The two authored a wide-ranging paper on candidate Trump’s economic plan that labeled China “the biggest trade cheater in the world.”

In a separate commentary for CNBC during the campaign, the pair enumerated their differences with Democratic presidential nominee Hillary Clinton over trade with China, noting:

“Clinton lobbied for China’s entry into the WTO in 2001, promising China would ‘play by the same open trading rules we do.’ Instead, the U.S. has had to file WTO case after case against China’s questionable trade practices on products ranging from apparel, aircraft, and autos to shrimp, steel, and textiles.

“Despite numerous WTO ‘victories’ for the U.S., most have been pyrrhic. It takes years to adjudicate a case. In the interim, American companies go bankrupt, China takes over the market, and the court ruling becomes moot.”

Congressional Support for Tougher FDI Rules

Congressional lawmakers, meanwhile, have requested that the Government Accountability Office (GAO) review and consider broadening the scope of CFIUS’ mandate in assessing FDI transactions. A bipartisan group in September urged the committee to determine whether its statutory and administrative authorities have kept pace with the growing scope and number of foreign acquisitions in strategically important sectors in the U.S.

House lawmakers requested that GAO determine whether CFIUS’ purview be broadened to (1) require a mandatory review of all controlling transactions by Chinese state-owned and state-controlled companies investing in the US; (2) add a net-economic-benefit test to the existing national security test that CFIUS administers; and (3) prohibit investment in a U.S. industry by a foreign company whose government prohibits foreign investment in that same industry.

Depending on GAO’s recommendations, expected sometime later in 2017, foreign acquisitions of U.S. technology companies may be poised to come under much closer scrutiny.

How to Influence Chinese Actions

The report to the President, published in January 2017, recommended three foreign policy efforts U.S. policymakers should pursue. The question is, will the Trump Administration support the recommendations?

Boost the transparency of global advanced technology policy.

Reshape the application of national security tools, as appropriate, to deter and respond forcefully to Chinese industrial policies.

Work with allies to strengthen global export controls and inward investment security.